Why Luxury Retail Looks Lavishly Priced

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Many investors seem to prefer a more-upscale shopping experience when it comes to stock picking right now: They want luxurious names adorning their portfolios.

Over the last six months, some high-end retailing names have experienced fast, furious moves: Tiffany (TIF) has rocketed up 110%. Nordstrom (JWN) has catapulted 119%. See Ticker Shock from last week for more on TIF.

Investors have been willing to bet that the worst is now behind these companies. However, looking ahead, how these retailers perform depends on what kind of economic recovery we will experience, and whether the embattled consumer decides to start spending again.

There are reasons to believe that it could be tough going for consumers, given the nasty challenges they're still suffering: elevated unemployment, weak income growth, and historically high debt levels.

More to the point, even if consumers do start cracking open their wallets for diamond rings, leather purses, and designer shoes, grabbing the shares of these retailers right now still looks like a pretty risky bet: Some of them have now become too pricey to merit a buy.

Caution is a better investment strategy when it comes to this sector.

The most recent news out of the luxury space to thrill investors came late last week from Tiffany. For the quarter ended July 31, Tiffany reported lower profit and sales. However, thanks to cost cutting efforts (selling, general, and administrative expenses fell 14%), Tiffany managed to beat analyst forecasts and the stock popped.

On August 13, Nordstrom told investors that its second-quarter profit fell 27% while net sales dropped 6%. But the company managed to match analyst expectations and said that it exceeded its earnings plans through disciplined inventory and expense management.

But the problem for these companies is that cost cutting is limited. Ultimately, they will have to grow their top line, which could prove challenging. There are a lot of reasons to believe that personal consumption expenditures are going to remain weak for an extended period.

American consumers are still facing tough times that could very well have a lasting impact on their willingness to spend. They're suffering with an uncomfortably high unemployment rate of 9.4%, which is probably going to get higher. And they entered this downturn levered up to their eyeballs: Household leverage has never been this high at the start of an economic recovery, according to Deutsche Bank.

Stats like these led The New York Times over the weekend to question whether there has now been a decided cultural shift in this country. Because of this Great Recession, Americans might now be more interested in acting like their parents and grandparents did after the Great Depression: They want to save more and spend less.

Indeed, Americans were saving less than 2% of their income as recently as the middle of 2007, according to the Bureau of Economic Analysis. The rate has exceeded 4% in recent months.

For the luxury retailers, it's even more pertinent to gauge how the country-club set is faring these days.

Nigel Gault, chief US economist at IHS Global Insight, reminds us that, while we all own stock indirectly to the extent that we own pension plans, the individual ownership of stock is most heavily concentrated in the rich. That's bad news for the champagne-and-caviar crowd.

While the Dow has enjoyed a rip-roaring run since its low in March, it's still down 32% from its October 2007 high. Given that harsh reality, it's hard to imagine our well-to-do friends shelling out money like they once did.

But even if investors are willing to wager that the consumer bounces back, and demand for high-end goods rebounds, luxury retailers aren't looking like bargains right now, at least based on some measures.

For instance, Tiffany's price-to-sales ratio is 1.42 versus a 5-year average of 1.27. It has a price-to-book ratio of 2.21 versus a 5-year average of 2.16. Nordstrom is no longer looking like a bargain either, based on those metrics.

The shares of these luxury retailers might now be looking as expensive as the designer jeans and beautiful bling they sell us.

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